Kohl's Corp. Q4 2009 Earnings Call Transcript

| About: Kohl's Corporation (KSS)
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Kohl's Corp. (KSS) Q4 2009 Earnings Call February 25, 2010 8:30 AM ET


Wesley S. McDonald - Chief Financial Officer

Kevin Mansell - Chairman, President and Chief Executive Officer


Mark Miller - William Blair & Company

Chris Cromwell - Morgan Stanley

Adrianne Shapira – Goldman Sachs

Deborah Weinswig – Citigroup

Jeffrey Klinefelter - Piper Jaffray

Rick Bethel – BoA Merrill Lynch

Robert Drubel – Barclays Capital

Charles Grom - J.P. Morgan

Wayne Hood - BMO Capital Markets


Good morning, may name is Jamika and I will be your conference operator today. At this time I would like to welcome everyone to the Kohl's Quarter Four Yearend 2009 Earnings Release Conference Call. (Operator Instructions).

Statements made on this call including projected financial results are forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in such forward-looking statements.

Such risks and uncertainties include those that are described in the Item 1(a) in Kohl’s annual report on Form 10-K and as may be supplemented from time to time in Kohl’s other filings with the SEC, all of which are expressly incorporated herein by reference.

Also, please note that replays of this call will be available for 30 days but this recording will not be updated so if you are listening after June 14th it is possible that the information discussed is no longer current. Thank you.

I would now like to turn the call over to Wes McDonald, Chief Financial Officer. You may begin.

Wesley McDonald

Thank you. With me today is Kevin Mansell, Chairman, CEO and President. I’m going to talk about our financial performance and then Kevin will walk through some of our merchandizing, marketing and store experience initiatives. And then, I’ll conclude with our earnings guidance for both the quarter and the year.

From a financial performance perspective, total sales for the fourth quarter were approximately $5.7 billion this year, up 8.5% from last year. For the year, total sales increased 4.8% to $17.2 billion.

Comp sales for the quarter increased 4.5%, driven by a 7.3% increase in transactions per store for the quarter. Average transaction value decreased 2.8% as our customer continues to purchase fewer items per transaction. Average unit retail increased 0.3% for the quarter. All regions and all lines of business reported positive comp sales results for the quarter.

Driven by increasing momentum throughout the year, which carried into the Holliday season, we ended fiscal 2009 with a 0.4% increase in comparable store sales. Transactions per store increased in eight of the last nine months of the year and ended the year up 2.4%.

Average transaction value decrease 2% as our customer continued to purchase fewer items per transaction. Average unit retail increased 2.3% for the year.

Our credit share was 47.3% for both the quarter and the year, an increase of approximately 290 basis points in both periods.

Our gross margin rate for the quarter was 36.4%, up 162 basis points from last year. For the year, our gross margin increased 88 basis points to 37.8%. The increase reflects continued improvement in inventory management, lower clearance levels and higher penetration of private and exclusive brands. We will expect gross margin to increase 20 basis points to 30 basis points for both the first quarter and the year.

Moving on to SG&A. SG&A for the fourth quarter was about $1.2 billion, an increase of 8% for the quarter and for the year, $4.1 billion, an increase of 5%, slightly more than our expectations due to higher than expected sales.

Store payroll, advertising and IT expenses leveraged in both periods. Distribution centers leveraged for the year but not for the quarter due primarily to increased payroll costs due to better than planned sales in both stores and e-commerce.

Credit expenses did not leverage for the quarter due to cost incurred to prepare the portfolio for additional legislative changes effective in the first quarter of 2010 but we are essentially leveraged for the year.

Corporate expenses did not leverage for the quarter and year due to increased incentive compensation and changes made to our non-management compensation structure. We would expect SG&A expenses to increase 4% to 5% for both the first quarter and the year.

Depreciation expense was $155 million for the quarter and $590 million for the year, an increase of 8% for the quarter and 9% for the year. The increases are primarily due to new stores and remodels. Depreciation is expected to be approximately $645 million in fiscal 2010 and $155 million in the first quarter.

Pre-opening expenses were $3 million for the quarter, $1 million lower than the prior year quarter and $52 million for the year, $10 million higher than fiscal 2008. We opened 56 stores in 2009 compared to 75 stores in 2008.

Even though we opened fewer stores in 2009, pre-opening expenses increased because a larger percentage of our fall 2009’s new stores were treated as ground leases. Pre-opening expenses are expected to be $20 million for fiscal 2010 and $5 million for the first quarter.

Operating income increased 26% or $149 million for the quarter to $722 million. For the year, operating income was $1.7 billion up 11% from 2008. Net interest expense increased to $31 million for the quarter compared to $30 million in the prior year, primarily due to lower interest rates on our long-term investments and reduction in capitalized interest due to lower capital expenditures.

For the year net interest expense was $124 million, up $13 million over 2008. Interest expense is expected to be approximately $125 million for fiscal 2010 and $33 million for the first quarter.

Our income tax rate was 37.6% for both the current quarter and the year. We expect our 2010 tax rate to be approximately 37.9% for both the first quarter and the year.

Net income increased 28% to $431 million for the quarter and 12% to $991 million for the year. Diluted earnings per share increased 27% to $1.40 for the quarter and 12% to $3.23 for the year.

Moving on to the balance sheet metrics. From a square footage perspective for your model we currently operate 1058 stores compared to 1004 stores this time last year. Gross square footage was 93 million square feet a yearend 2009, compared to 89 million at yearend 2008. Selling square footage increased from 75 million at yearend 2008, to 78 million at yearend 2009.

Cash and cash equivalents. We ended the year with $2.3 billion of cash and cash equivalents, an increase $1.6 billion over last yearend. The majority of the cash equivalents are in money market funds.

We are currently in the process of negotiating a new credit card agreement and have a number of interested banks. We expect to reach a decision on that agreement in late spring or early fall with the timing dependent on finalization of credit card legislation.

Our inventory levels reflect improved inventory management as we refine our processes to better match receipts with sales. Total inventory was up 4.4% compared to the prior year, while inventory per store was down approximately 0.9%. Clearance units are down approximately 14% per store.

Capital expenditures were $666 million for the year, 34% lower than 2008. For 2009 we generated approximately $2.2 billion in cash flow from operation and $1.6 billion of free cash flow. Free cash flow increased $884 million over last year’s $684 million of free cash flow.

Our expectation for 2010 for CapEx is now $900 million versus our previous guidance of $750 million. The increase is due to the addition of 20 remodels for approximately $50 million moving our total from 65 remodels for 2010 to 85 remodels in 2010 as well as the purchase of a second ecommerce distribution facility on the West Coast and significant investment in our website to support the tremendous growth of our ecommerce business.

Ecommerce revenues increased 38% in 2009 on top of a 48% increase in 2008. Our projected 2010 free cash flow is approximately $800 to $900 million.

Moving onto accounts payable, AP as a percentage of inventory was 40.6%. Last year’s AP as a percent of inventory was 31.5%. Weighted average diluted shares were $308 million for the quarter and $306 million for the year. We’ve not repurchased any of our stock since July 2008.

And with that I’ll turn it over to Kevin to talk about some of our merchandizing initiatives.

Kevin Mansell

Thanks Wes. As Wes mentioned comparable store sales increased 4.5% for the quarter and 0.4% for the year. All lines of business were positive for the quarter. Footwear and accessories outperformed the company for the quarter.

Women’s and home ran approximately even with the company, while men’s and kids trailed the company. Footwear and women’s had the most improved performance in the quarter over the year-to-date trend.

In footwear, this was driven by women’s shoes and athletic shoes. And in women’s apparel, this was driven by substantial improvement in our key private brands performance of Sonoma, Croft & Barrow and Apt. 9. All three brands achieved very strong fourth quarter increases.

For the year, footwear, accessories and home outperformed the company. All regions were also positive for the quarter. The southwest region achieved a high single digit comp with the northeast, southeast and mid-Atlantic in the 3% to 4% range.

The Midwest and south central regions achieved low single-digit comps. The southeast region had the most improved performance in the quarter over the year-to-date trend. Many of our initiatives to more effectively tailor our assortments regionally appear to be gaining momentum in this region.

For the year, the southwest was the strongest region with a high single-digit comparable store sales increase. The southwest benefited our company comps a little over 100 basis points for the year and due to other strong regional results nationwide to a lesser degree in the fourth quarter.

We expect to continue to produce strong results in the southwest in 2010, but out other hot and mild regions will benefit much more substantially this year from the merchandizing and marketing tactics we develop last year in the southwest.

Total ecommerce revenues increased 38% to almost $500 million in 2009. This follows a 48% increase in 2008. As Wes indicated earlier, we're making a major new investment in capital and infrastructure in our ecommerce business to fuel future growth. Based on our research, our testing and our own results, it appears that our opportunity in this business is substantially larger than we originally envisioned.

Moving on to our merchandize initiatives, the following merchandize initiatives are new to spring 2010 and include the following. LC Lauren Conrad, our exclusive partnership with Lauren Conrad launched in October 2009 in approximately 300 Kohl's stores and on Kohls.com.

LC Lauren Conrad will be rolled out to all stores nationwide in March. We accelerated the rollout due to better than expected sales in the fourth quarter. Our original plans do not call for rollout into the fall of 2010.

Our exclusive Mudd Brand launched in juniors and girls for back-to-school and also far exceeded our internal plans. Consumers have embraced the brand as a bridge between our opening price point So Brand and our best price point Candies Brand.

Our newest private brand Helix launched in all stores earlier this month. Helix is an opening price point brand positioned in our contemporary good lifestyle price zone and will be featured in young mens tops, fashion bottoms and shorts. This fills a major void in our assortments in these areas.

The success of our recent launches as well as our other exclusive and private brands, continue to drive increased penetration of these brands. Exclusive and private brand sales as a percentage of total sales increased approximately 200 basis points to 42.7% for the quarter and 220 basis points to 44.3% for the year.

We saw consistent improvement in our three major private brands, Croft & Barrow, Sonoma, and Apt. 9, as all three achieved double-digit positive comps for the fourth quarter and positive comps for the year.

Strong exclusive brand performance for both the quarter and year include ELLE, FILA, Food Network and Simply Vera, Vera Wang. We are also very pleased with first year performance of our Dana Buchman brand as well.

Moving on to inventory management, as we indicated earlier, average inventory per store is approximately 1% lower than last year, with clearance inventories down over 14% per store.

Our cycle time process improvements on fashion categories and a focus on replenishment of basics have allowed us to consistently flow receipts with sales and improve our inventory effectiveness by merchandise area and by store location.

We were able to pull receipts forward to support our better than planned sales that we achieved during the holiday season allowing us to achieve a strong January comp with very little clearance.

As a result, our AP to inventory ratio reached over 40% at the end of the year, the highest since 2002 indicating the freshness of our inventory entering the spring season.

Our size optimization initiatives also continue to develop and we expect significant benefits this fall with the goal of all of our sized receipts on the program by fall 2010. We saw improvement in in-stock levels of 3 to 5% in these programs in fall of 2009 leading an increased sales and better customer satisfaction.

And finally marked on optimization will continue to benefit us in this fourth year of use even with these lower inventory levels. We would expect our inventory per store at the end of the first quarter to be up low-single digits on a per store basis similar to our expectations for the year.

As Wes mentioned we expect gross margin for fiscal 2009 and the first quarter to be up 20 to 30 basis points over last year. This guidance factors in the following items. We achieved significant improvement in gross margin last year and hit an historic high.

However, we believe will experience continued improvement in inventory management as well as increased penetration of private and exclusive brands in 2010, which will allow us to continue to grow gross margin.

Some of that benefit expected from those improvements will allow us to fuel sales in market share gains, marketing cap fix and pricing flexibility that we believe will be necessary to continue to lead on the top line. The consumer continues to focus on value and we intend to deliver that value again this year.

From a marketing perspective throughout 2009 our marketing efforts were based in highly effective, The More You Know, The More You Kohl's platform. We’ll continue to utilize this platform in 2010 with a goal of motivating our customer to shop at Kohl’s more often by strengthening or understanding of why Kohl’s is the smartest choice. We’ll accomplish this by focusing on our total value, increasing our regional relevance, and explaining our differentiating practices.

Cleary we got the message across in 2009 that there are many ways to stay with Kohl’s. In 2010, we’ll intensify our value message nationwide with those tactics that proved to be most effective. In 2010, we’ll also continue marketing efforts that increase customer knowledge and build relevancy by region especially in key hot and mild markets.

We learned a tremendous amount from our efforts last year in the Southwest and plan to deploy some of those tactics to our southern markets in addition to raising our level in the Southwest.

And finally when it comes to differentiation, we want to amplify what makes Kohl’s the smartest choice everywhere. We have always put the customer first. No hassle policies and programs are the foundation of Kohl’s and how we do business, and we’ll continue to focus on that.

We’ll continue to differentiate ourselves from the competition through no hassle return policy, our world class exclusive brands, our no exclusions approach to value added offers, Kohl’s Cash and our Kohl’s charge program.

The efforts we put behind these marketing programs are resonating with our customer. We see it in our research and from more than 900,000 Facebook fans; in addition to sharing their experiences with their friends and family, our Facebook fans communicate to us and to each other in real time.

On the store experience front, last year we successfully used our strong financial position to continue to expand in new and existing markets, accelerate our remodel program and focus on delivering value in order to grow market share at the expense of competition. In 2010, we are planning to do the same.

We will open approximately 30 new stores in 2010 with nine openings in the spring and the balance opening in the fall. In addition, we plan to remodel 85 stores in the spring season and increase from the previously planned 65 stores and the 51 remodels in 2009. These remodels will be split into three ways and reopened in March, May and August.

We have been able to compress the remodel duration from 16 weeks to nine weeks over the last two years in order to minimize the disruption and the cost to our stores. We have also learned from our market intensification efforts as to the most effective ways to attract first time shoppers and former customers who have not recently shopped at Kohl’s. We think this should help our sales post re-grand opening.

The increase in the number of remodels differentiates us from the competition and we think is a critical part of our long-term strategy. And in addition, remodels and new stores in 2010 will contain a dramatically redesigned home area, which will allow us to have more capacity on the sales floor and provide more flexibility in our fixtures.

We continue to see high customer service scores as a result of merchandized content, inventory management and marketing initiatives as well as the efforts of our store teams to engage the customer and achieve the 7% improvement in our customer service scores in our stores over the last year.

The customer will be choosing a select number of stores to shop in this environment. We want to remain at the top of the list and we will continue to invest in customer service in 2010.

In 2009 we tested in-store kiosks that provide customers with an easy way to order an item that we may be out of stock in size or color in that store. She could also choose from an expanded assortment of items not available in store.

In both cases should could have those items shipped free of charge. The test was very successful and we’re rolling out our in-store kiosk initiative to all stores by the beginning of fall 2010. We expect these to be another major driver of market share.

Just in closing, before Wes gives you our guidance. At the beginning of 2009 we indicated to investors we expected to out perform our competitors on a number of metrics.

But we were most intensely focused on two particular areas, market share gains and continuing to invest in our future, by improving our businesses, business processes through technology, investing opportunistically in new stores and accelerating and improving our remodel strategy.

We have achieved those results and more. We’ve gained significant market share nationwide. Success has been spread across merchandize areas and regions, especially in the most recent fourth quarter.

Our fourth quarter net income increase of 28% and 2009 annual increase of 12% reflect the success of our strategies and our ability to generate sales growth and market share gain and still improve profitability.

As I indicated earlier, the sales gains were driven by improved perceptions of Kohl's value equation compared to our competitors. Much of that improvement was driven by sustainable improvements in our business model, through implementing new technology and by continuing to open new stores in an opportunistic real estate environment as well as expanding the impact of our remodel strategy.

We intend to accelerate those improvements with the expansion of our remodel effort and a new investment in ecommerce and store experience infrastructure elements like the kiosks strategy.

In addition we continue to experience specific improvements around inventory management that are leading to improved gross margins, which were up a 162-basis points in the fourth quarter and 88-basis points for the year.

We are flowing our receipts more efficiently and timely as witnessed by the freshness of our inventories and as indicated by our own finer sound, size and color and customer service scores.

These improvements helped us to achieve significant free cash flow of approximately $1.6 billion almost $900 million better than last year. Additionally our efforts to create a differentiated brand portfolio around exclusive brand that have strong existing equity have led to a significant increase and penetration of these brands and to our total sales.

There has been immediate acceptance by consumers around brands like Simply Vera, Vera Wang, Chaps, Candie's, Tony Hawk, Food Network, Daisy Fuentes, ELLE, FILA SPORT and new this year Dana Buchman, Lauren Conrad and Mudd.

These brands had high consumer awareness to respect of launches in this mix improvement will continue to benefit gross margin results and position us for future new brands.

The recent doubling of our design office in New York is a testimony to our view of these opportunities for the future. Our partnership with Li & Fung has also dramatically aided in this process.

I was pleased with our ability to manage the expenses for the year. Most importantly, our improvement in key areas like stores and advertising was driven by sustainable productivity improvements, not one time cutting of expenses.

While we continue to look for ways to become more efficient, we intend to keep as a priority the customer experience in order to provide consistency across our store base and continue to be aggressive on the marketing front to gain market share again in 2010.

With that, let me turn it back to Wes to share our initial guidance for 2010 and the first quarter.

Wes McDonald

Thanks Kevin. Implied in our guidance is the fact that we expect demand to continue to be weak throughout 2010 with comps being driven by taking market share from our competitors as we expect average transaction value to remain under pressure.

We will use the advantages we described to intensify our value position to maximize our sales. We would expect to continue to outperform our competitors in both total sales growth and comp sales growth and gain market share in 2010 just as we did in 2009.

For both the quarter and the year, we would have the following assumptions. A total sales increase of approximately 4% to 6%, comp sales increase of positive 1% to 3%, gross margin increases of 20 basis points to 30 basis points over last year and SG&A dollars to increase 4% to 5% over last year.

Our sales expectation by month for the first quarter are, for February to be ahead of the quarter, March to be high single-digit to low double-digit positive comparable store sales increases and April to be negative high single-digit to low double-digit comp sales decreases.

The disparity of the March-April comps is due to the timing of Easter and of our brand opening events. This would result in earnings per diluted share of $3.40 to $3.63 for fiscal 2010, and $0.48 to $0.52 for the fiscal first quarter. As always this guidance does not reflect any additional share repurchases in fiscal 2010.

With that we’d be happy to take some questions.

Question-And-Answer Session


(Operator Instructions). Your first question comes from Mark Miller - William Blair & Company.

Mark Miller - William Blair & Company

Development capabilities having substantially boaster the organization, where do you think that infrastructure can take you long-term in terms of the exclusive and private label penetration? And then in terms of cycle times if you could update us where you are there and what your objectives are going forward?

Wesley McDonald

In terms of the future on private and exclusive brand I think we would limit it to just say that we're very confident that in 2010 our private and exclusive brand penetration will continue to rise.

And that's just the factor of the rate of growth of those brands throughout 2009, fact that there are a number of new brands that aren't annualized in 2010. It doesn't contemplate any additional future brands to be added to our roster but I would expect that that something that will happen.

In terms of cycle time I think we've made really good progress, from my perspective the best metric to look at in that regard is our inventory turn and the freshness of our inventory and the level of out of season inventory we have and all those metrics we are improving consistently. We probably made the most improvement as you would expect, in areas that are more fashion related and that are longer term cycle, supply days.

We've continued to fund inventory basics and so our turn improvement hasn’t been as strong there.

Mark Miller - William Blair & Company

On the gross margin improvement how much does that contemplate in terms of further private label exclusive mix penetration gain this year?

Wesley McDonald

It's just a factor, I mean I think we said in the closing remarks that our gross guidance implies several things. One of course we did achieve a very high margin last year, two we know though this year we have a strong tail wind with more private and exclusive brand and we believe more improvement in inventory management.

We are going to use some of that though, just as we did last year, because we still are focused primarily on market share gains. So it factors in all of those things together, the positive side and then using some of that benefit to drive sales.

Mark Miller - William Blair & Company

My other question is would you be willing to share with us some perspective on the tactics that were so success for you in the southwest and how will you be using those in the other warm-weather markets?

Wesley McDonald

No. Sorry, the answer is no. (Inaudible) the whole time you were asking that question.


Your next question comes from Chris Cromwell - Morgan Stanley.

Chris Cromwell - Morgan Stanley

Hi, this is Chris Cromwell filling in for Michelle. Just a question, if you could dive a little deeper on SG&A, I think you said in the past that you need about a flat comp to leverage SG&A and there were obviously headwinds in the fourth quarter. Could you talk about the leverage points going forward and the sensitivity around that?

Wesley McDonald

Yes, I mean I think in January where we didn’t go as it leveraged to the flow, we de-leveraged for the year at a 0.4 to 11 basis points. Our goal for 2010 is to try to continue to get to that flat point realistically for remodeling purposes, I think it would probably prudent to use a 1% leverage point and then our normal around 8 basis point above that for every 1% above the one.

Kevin Mansell

The other thing and I think Wes mentioned this in the call but one of the factors on SG&A is we made a very conscious decision to invest in customer service at our store and keep the level of service at what it needed to be throughout the 2009 year and I think that was the piece of the reason the results were what they were.

Chris Cromwell - Morgan Stanley

If I could just one other on square footage growth, when we think about 2010 we’re getting in the neighborhood of about 4% square footage growth, this is a little bit lower than the 6% you did in 2009.

Do you think there is more opportunity above your intended square footage growth in 2010 perhaps as a result of competitive failures, did you see that number potentially going forward, I should say going higher if there are no incremental opportunities arising from competitive failures.

Kevin Mansell

Not for 2010, we would have needed to have taken possession really in February to open the store this year. Hopefully we’ll continue to put pressure on some of our competitors as they rationalize their fleet, there could be opportunities in the future 2011 and beyond but nothing additional for this year.


Your next question comes from Adrianne Shapira – Goldman Sachs.

Adrianne Shapira – Goldman Sachs

Kevin, just on the comps, I appreciate the breakdown on monthly basis. But it just seems like you’re up against easiest year-ago comparison of the first quarter. So just kind of help us think about that 1 to 3 for the quarter it seems that it would suggest deceleration for more you’ve been running in the back half. So perhaps shed some light on that for us.

Wesley McDonald

Hope you can tell us when it’s going to stop snowing in New York, that would be helpful.

Kevin Mansell

I think, to be honest Adrianne, we kind of looked at it on an annual basis first and foremost. And really took a hard look at our trends in the third and fourth quarter. And you’re right; I mean our actual trends in the third and fourth quarter comp were better than the guidance given in the first quarter.

We still know that we’re facing a strained customer; we still know we’re in very tough economic environment and we know we’re turning a leap into a new year. So I think both Wes and I felt we’re comfortable being conservative about our due.

Our guidance is always really based on our trends, which are of course adjusted for the economic environment and typically I don’t think it’s unfair to say that we would be conservative just to ensure our shareholders and our investment strategies are protected.

And so that what’s factored into the sales guidance. There isn’t any thought in our mind that this is something in the first quarter that would decelerate our trends.

Adrianne Shapira – Goldman Sachs

Okay, so it’s not as if any of strong traffic trends or even improvements that saw you on AUR have moderated even in February from what you were seeing in the fourth quarter?

Kevin Mansell

We don’t report until next week. We have two days left in the month and Wes just indicated on the guidance that February will be higher than the quarter.

Adrianne Shapira - Goldman Sachs

On the point about, you have been gaining share at the expense of others, as you have been doing last year, but others seems to be gunning for the share too, that seems to be sort of a popular play book this year.

So I am just wondering, it sounds as if you’re looking to perhaps invest some of the margin opportunity to drive sales, maybe comments in terms of what you have been seeing out there in terms of the competitive environment. Have you seen any more aggressive stands as others are going after share as well?

Kevin Mansell

There isn’t anything specific that I could call out, I mean I think we are aware of what other company strategies are. Ours are pretty the same I mean we have, as you well know, long-term not just last year been a major market share gainer.

So, strategy calls to drive market share are nothing new, it’s not unique the last year, its not going to be unique to this year we’re very focused on driving top line sales. So that long-term view kind of plays into our future view as well.

The key element for us for 2010 is we did have enormous success in the Southwest, particularly in the West Coast and we did employ a lot of merchandising tactics and a lot of marketing tactics that we saw were really successful.

We are able to now take those particularly to markets where we think there are more opportunity, the Southeast might be a great example of one and to apply those same merchandising and marketing tactics and that’s why we feel good, both because of long-term trend of share gain and our shorter-term tactic success that 2010’s going to be another year for market share gains for Kohl’s.

Adrianne Shapira - Goldman Sachs

Kevin just on the remodels, it seems like obviously you are pleased with what you are seeing accelerating that to 85 this year.

Give us a sense of how that too is helping to widen the competitive mode as you – what you're seeing on those remodels, it sounds like a lift is helping with the pre-grand opening. But any sort of sense of returns and how that’s continuing to improve?

Wesley McDonald

Well I think we learned a lot in our third wave of remodel, we were able to take some of the tactics that Kevin mentioned that we used to in the Southwest and employ them in our remodeled stores. We were actually able in our third wave to get a lift post re-grand opening that offset the drop during construction.

We've been able to mitigate the construction drop by shortening the duration of the construction, but not eliminate it. So that’s the first time we've had any significant lift in total. We’re going to take that and intensify it for our three waves in 2010 and hopefully improve on it.

It’s not the same returns in new store we don’t change the mix of merchandize like some of the other guys do to drive comps. It’s really just an investment in the future. But by getting an overall lift through the period that we model, it’s a big improvement from where we were and that’s why, one of the reasons we decided to do more in 2010.

Kevin Mansell

I mean that other thing Adrianne is that we really try to focus investors around this. When we do these wavy type remodels, of course we have one new wrinkle this year which is a completely new home area and of course the implementation of this kiosk strategy. But I think you'd be hard pressed to see the difference in those wavy type remodels from a new store.

Everything that you see in a new store in those remodels, there isn't any part of a remodel that’s not touched or changed and updated and so we kind of feel like we’re giving those customers a new store. That’s why we feel so good about it.

Adrianne Shapira – Goldman Sachs

Great it make sense and just last question Wes, the free cash flow generation, clearly very strong what – how do you think about that ideal capital structure and where a dividend fits in potentially? Thank you.

Wesley McDonald

Well, I think for right now we’re focussed on renewing our credit deal. Until that happens I think it’s premature to talk about what to do with the free cash flow. And certainly conversations we’ll have with our board in the future this year, but at this point we haven’t contemplated a dividend.


Your next question comes from Deborah Weinswig – Citigroup.

Deborah Weinswig – Citigroup

If you are so confident on (cycling) the southwest from year ago and performance of private exclusive brands and higher performance versus the competition then can you help us to understand the comp guidance, which is in line slash below most of your competitors?

Kevin Mansell

Well, I haven’t seen anybody who is really got higher guidance. To be real honest with you Deb, the way we’re looking at this is first and foremost there is a very difficult economic environment and nothing has really fundamentally changed about that and the consumer is continuing to be incredibly strained.

So we are always going to take the approach that we’re going to give guidance, that we’re going to work hard to over achieve or we’re going to give guidance in which we are confident in achieving because I think that’s what we owe our investors, to not stretch that and not to be caught in a position where we get ahead of ourselves or get more importantly, ahead of the consumer.

So it’s out best view. We are going to work real hard to do better. And I just spend a lot of time describing the tactics that we have to do that. I think if you’re honest in analyzing those and you look at it from a long-term movement perspective, we’ve been the clear winner and so and the odds of us achieving are very strong.

But we are going to always stay conservative in our view.

Deborah Weinswig – Citigroup

Okay, I just want to make sure, it’s not like you’re being conservative. I just kind of wanted to kind of flush that out. And then if we think about the marketing plan, which obviously was extremely successful in the fourth quarter. I know there has been a big focus on increasing cross shopping. Can you talk about the success that you are having there and anything else you are doing to drive that?

Kevin Mansell

Sure. I mean the biggest success obviously, impacts the accessory area. Accessories led the company in terms of sales for the year and I think with footwear, led the company in the fourth quarter. And you are seeing that particularly in two key areas, primarily jewelry, uniquely fashion and sterling jewelry.

Those areas get big benefits from a cross shopping standpoint throughout the women’s and juniors’ area. Second handbags, again one of the leading categories in accessories. So you are seeing cross shopping success basically directly in our business performance by area.

We are seeing it in other ways as well that aren’t so statistically related. But we are clearly seeing it drive our jewelry market share gain. We have very strong performance for the year and the fourth quarter in accessories and jewelry and a big chunk of that was driven by these cross shopping tactics.

Deborah Weinswig – Citigroup

And then on the gross margin front, I think you are one of the only retailers we’ve followed that actually had positive gross margin performance in the fourth quarter of 08, which makes your performance in the fourth quarter of 09 even more notable.

Can you discuss obviously how the gross in private and exclusive brands and you also have lower inventory levels etc, but can you dive into some more of the details around size optimization and mark-down optimization? Because it feels like you have tools which maybe have been rolled out for sometime but maybe you're deriving greater benefits as the buyers etcetera, continue to utilize them more but also maybe there's additional functionalities etcetera. If we could just maybe have some additional color on that?

Kevin Mansell

Well, the two things that are aiding margin obviously, we've made a content changes to improve what we're offering customers. The most important is the style and the value of what we sell. But I think the way Wes and I look at it is, the most successful margin strategies are going to be supported with a board number of different tactics to achieve them so that we don't regret to show the position where we're relying on one of them for instance, just relying on improved private and exclusive brand penetration. But you named four or five and every one of those aided our performance.

On the technology front I'd say that we’ve consistently seeing that after we roll technology out we get a lift. But we usually get a number of years lift after that because you refine the tool and the tool improves on itself.

And I think that's kind of what we're seeing. We're certainly hoping that size optimization will do the same thing when we eventually get it all rolled out in fall 2010. We're looking forward to several years of improved performance because of that. So it's a factor of a lot of different things.


Your next question comes from Jeffrey Klinefelter - Piper Jaffray.

Jeffrey Klinefelter - Piper Jaffray

One for Kevin first, again just on this not to beat the dead horse in this guide, but given the acceleration that you're hearing at least from other competitors as they're looking on 2010. Do you anticipate needing to take a little bit more cautious approach to reserving, as a promotional activity, as a proactive promotional activity in order to maintain your share gains, is that something considered in this guidance?

The other thing is on the productivity of southwest stores after the strong comp last year, are they still below the average productivity of your chain?

Kevin Mansell

On that, back to guidance. Don't forget Jeff there is a difference between guidance and actual results, right? The guidance is just some company's view of what they think will happen. You actually have to achieve that. In our view we have a track record now that supports our ability to deliver comp store sales increases and at the same time we recognize it's a very competitive environment and it’s a very strained consumer.

So we are going to be realistic about the level of those increases, so that the investment decisions that Wes allows the teams to make are related to that level of increase. And as we over achieve, I think a lot of people will be happy. But we'll be very safe in the guidance we gave.

Wesley McDonald

Yeah, I mean you know how we do it Jeff? We ran a 0.4, that's the low end, it is the one. We achieved the 4.5, which had a benefit of the extra day in December which was worth about a 100 basis points on the quarter. That's the 3 and change. So we guide to what we've already achieved, we are not looking for any improvement.

And answering your question about California, depending on the market, they run around 85% to 95%, San Diego is actually above the average store now. So we still feel like we have opportunities to get those to the average store, which means, I know there is a lot of concern out there about our ability to lap the (inaudible) benefit, but those stores are still below the average in the company.

We still believe we have more customers to attract. So we believe we are not going to probably run 20 comps out there this year like we did in some quarters last year but we can over achieve the company comp out there certainly.

Jeffrey Klinefelter - Piper Jaffray

This process pretty important given how strong the penetration is for your credit customer, can you just share a little bit more on that process on multiple banks considering, it is JP Chase one of them, how is this impacting your cash utilization during the year in terms of buyback and other things.

Wesley McDonald

Chase is still very much part of the process and a very good partner, I think the process itself is, we’re still in the preliminary stages so I don’t want to talk a lot about it. We do have more than one bank interested.

As far as the cash goes, I think realistically until we get a deals and extension signed like Chase or a new deal with someone else it would be prudent to keep our cash around until that’s completed.


Your next question comes from Rick Bethel – BoA Merrill Lynch.

Rick Bethel – BoA Merrill Lynch

Can you talk about your target store count, perhaps give us an idea of what number you are working for and how should we think about the pace of new store openings beyond 2010?

Kevin Mansell

We don’t really have any guidance beyond 2010, I mean I think Wes and I both have the same point of view which is in the past we’ve looked out in the future and identified significantly more store locations for Kohl stores and we have at the end of this year coming 2010.

But the path to get there is going to be totally and completely determined by consumer demand, the performance of our competitors, of course our own performance and the ability for us to identify real estate locations to give our investors a good return.

And so, those are the factors, and we certainly expect growth in the future and we’re planning for growth in the future, but we’re not prepared to give you numbers for and beyond 2010.

Rick Bethel - BofA Merrill Lynch

And can you update us on what you’re expecting in terms of -- as we go through 2010 are you still expecting inflationary pressure as we exit this year?

Kevin Mansell

No, I mean our 2010 view has evolved naturally -- most of the first half of the year has already been placed in– general view would probably we’re down in cost of goods in mid single digits or so. For the fall, it looks like we’re going to be down in the low single digits or so.

We don’t have as much bills ability specifically in holiday receipts but we have a big chunk of the year visibility and costs are down again this year.


Your next question comes from Robert Drubel – Barclays Capital.

Robert Drubel – Barclays Capital

Wes, I just had a follow up question on the credit card business. I know it’s at the early stages but do you think the economics even with the legislative changes that are in place, on the renewal side of it, will it be equal to what you were able to achieve in the last deal?

Wesley McDonald

We’re in a very, very preliminary stage, so I’m not really confident about commenting on that. And the legislative effect, I think as some of our competitors talked about in their earnings call as well, remains to be seen.

The biggest remaining piece out there is late fees and that has to be decided no later than August, which is kind of the reason of the timing I have, late spring, early fall. Once that’s decided, clarity on the economics to deal will be a lot better than it is today, but it would be premature for me to speculate on the economics at this point until that’s decided.

Robert Drubel – Barclays Capital

And Kevin just a quick question for you is – on the footwear business, when you look at the strength of the footwear especially in the fourth quarter, could you tell us how much was like average ticket to footwear sales were and sort of how much that benefited you and – and if you actually – as you look forward over the next few quarters, does that concern you on your ability to comp in, in such a strong cycle for the footwear, the boots business et cetera.

Kevin Mansell

No, I don’t think so. I mean seasonal was good obviously and I think it was good for many people not just Kohl’s. But we had pretty broad success, our athletic footwear business, very, very incredibly strong; our kids business was very, very strong.

So footwear outpaced the store significantly in the fourth quarter. They outpaced the store for the year, not as significantly, but did outpace it as well for the year.

So I think footwear success, to be totally frank with you Bob, is primarily about better style, its better value and Wes was mentioning SKU reduction. We have a strategy in there that’s part of our inventory management tactic which is to reduce the number of SKU’s in the footwear area in order to focus our inventory investment behind fewer offerings but guarantee in stock as a result of that. And all those tactics and strategies are working.

So we benefited like a lot of people did, I think in the fourth quarter on boots, boots were good, but footwear was good the whole year.


Your next question comes from Charles Grom - J.P. Morgan.

Charles Grom - J.P. Morgan

Just a couple of questions on gross profit margins. First Wes, can you just dig in a little bit to the details on the 162 basis point rise in the fourth quarter and what was clearance, what was mix, what was IMU, if you can help us out there?

Wesley McDonald

I mean it was kind of all the above. I would say private and exclusive and markup was probably a little more than markdown only because -- to somebody’s point earlier we had a higher gross margin in the fourth quarter, we already cut clearance in the fourth quarter tremendously last year, but we didn’t get as much benefit as we did in the first three quarters. But this is really kind of a contribution all over, but more in IMU in the fourth.

Kevin Mansell

I mean the other thing that was not insignificant -- right Chuck was the fact that we purchased to and guided towards a lower comp performance and then significantly exceeded it. So the percentage of goods we sold at various points in the life cycle were very favorable.

Charles Grom - J.P. Morgan

Yes, got you. Okay makes sense. And then can you just help us understand size optimization for you guys? We've talked about it for a couple of years now. But what's the timeline here? You're talking the fall, can you give us a little bit -- how many vendors are on board or the number of skews where you are at today, just so we have some guide posts for the next year?

Kevin Mansell

I think in the spring we might have mentioned, sorry about not giving you the continuity, but we have about 70% of the size receipts on the program for spring. The fall is really where we get all the size receipts on. So we've seen, like I said in-stock improvements of 3% to 5%, which translates into better sales.

I mean big picture overall we’re increasing the penetration of smalls and extra smalls more than larges and extra larges as we enter some of the west coast regions where more smalls are in demand. That’s very high level, very simplified.

Charles Grom - J.P. Morgan

Okay fair enough. And then last one, the double-digit comp in the three private brands in the fourth quarter is impressive. Can you remind me what the trend it was for the first three quarters of last year?

And then also probably speaking, what the margin hierarchy is between private, exclusive and national, I know the direction, but maybe just to get a little bit granular what is that will be helpful?

Kevin Mansell

Well, trends in ‘08 third and fourth quarter on each of the private brands were generally kind of like this. In ‘08 we had a pretty good fall season in Apt. 9. We had a mid lean fall season, more like the store in Croft & Barrow, remember the store was down. And then in Sonoma we were disappointed and I think we were very transparent about that.

So it’s kind of mix, right? Apt. 9 actually it was coming off very good year, Croft and Barrow was coming off the year it looked like the store and Sonoma was coming off the year which was less than the store.

This year they all had very strong performance and Sonoma, high on the trend basis, had the biggest turn around. There was a dramatic turn around in Sonoma’s performance. And I think that’s definitely one of the reasons why you heard that the women’s business in the fourth quarter was basically about equal to the store and was, with footwear, the most improved trend in our whole business in the fourth quarter. So it made us feel good that we’re making better decision from our value and style perspective.

Charles Grom - J.P. Morgan

Okay, and then on the margin hierarchy Wes, do you have that?

Wesley McDonald

I mean the difference, we’ve consistently said, between private and national is around 400 basis points. And depending on the exclusive of arrangement the more it looks like a private brand the closer is to that. The more it’s like Chap’s on the men side, basically a wholesale deal it looks more like the national brand.


Your next question comes from Wayne Hood - BMO Capital Markets.

Wayne Hood - BMO Capital Markets

Kevin, I was just wondering, when you look at the performance in California, of the acquired stores or may even some of the no-acquired stores and you look at smaller versus larger markets and the performance differential between those two.

Are you seeing much of a difference that would kind of cause you to rethink about potential markets? You could go in there being larger, in other words going into smaller markets that you originally thought you couldn’t based on the performance of some of the smaller stores you are seeing right now?

Kevin Mansell

I don’t think there is a – no I would say the short answer is no. What we saw in the West Coast, particularly in California was that the biggest improvements in the existing store base came northern California to be fair. That’s where we had this biggest opportunity.

And from a performance versus plan perspective, it was relatively equal, both northern and southern on the new stores. But basically after the opening began to make plans across the new stores, some did better, some did worse, just like they always do.

So I don’t think – I think the big learning from the southwest experience is 2009, and in particularly California, was that the tactics that we have employed from a content perspective to tailor our assortments more affectively by region, make our assortments look right in California and then drive customers in to those stores with those new assortments with tailored marketing tactics that appeal to that customer worked.

That’s why we gained share to a great extent in California. And it was pretty much across the portfolio. It is also why you heard us talk a little bit about being very focused on the other mild and hot regions this year because we think that we can do some of those similar things than those other regions.

And as you know, those regions typically have not performed as well as a percent of average store. So we have opportunity.

Wayne Hood - BMO Capital Markets

Yeah. And so just to follow up on that, Wes has talked to us all about, I think about 30 stores for the foreseeable future I mean what's the probability and what would have to happen for it to fall to below 30 or even be above that? What are of metrics beyond funding that you're looking for that would cause that to move one way or other in a material way?

Kevin Mansell

Well, for beyond 2010, if Wes –

Wesley McDonald

That's more my saying if you guys have to model, pick our current run rate and blow it out how many ever years you want. I think in order to accelerate from that, we’ll have to see an improvement in the economy and more developments getting done. A lot of us are being conservative with our developments. No secret, we tend to partner with guys like Target and Wal-Mart and Best Buy and Clothes and Home Depot and all of us are being relatively conservative in the environment.

Kevin Mansell

And the other factor that we would expect, at some point we will be helped with, which is what happened in last year is, that there were other failures of competing concepts and those stores become available for a better concept, which was ours and we were able to acquire real estate really opportunistically.

So I think that will still happen for sure. It may not happen in one big lump sum like it did with the (inaudible) situation. But that's the other thing that we would expect might propel the number.

Wayne Hood - BMO Capital Markets

Then Wes, my final question is around SG&A growth. You're at a remodel period here as well some other initiatives going on. As we looked at '011 and '012, would it be fair to assume that the SG&A dollar growth, not the rate, might loop back down closer to three to four rather than four to five or how much is this activity really putting some pressure on SG&A dollar growth that normally kind of wouldn't be there?

Wesley McDonald

That’s a good question, because obviously there are some expenses associated with ramp up, the remodels.

For now, I will use four to five until we can prove that we can do better.


And your final question comes from Dan Binder – Jefferies & Co.

Wesley McDonald

Dan, you on there? Okay, I guess Wayne was our final question. Thank you everybody. I will available if you need me the rest of the day for follow-up questions. Thanks.


This concludes today's Kohl’s Quarter four, year-end 2009 earnings release conference call. You may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


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